One speech, many signals as the RBI hits out

Article Publisher: 
Published: Tuesday, 30th October 2018

In terms of a speech, it is unprecedented in its forthrightness and signals a pushback like none other. It marks an almost unprecedented waving of red flags to bring to the attention of people that the nation will have hell to pay if what is being said is not heeded at this crucial time.  And coming as it does from the top leadership of the Reserve Bank of India (RBI), it tells us that things are probably close to boiling point. In focus is the independence of the RBI, the central bank that, among its other roles, is the regulator for banks and is navigating through a critical time amid a host of burning issues, among them Non-Performing Assets (NPAs) of the order of Rs. 10 lakh crores that are crippling the banking system. This is not yet a crisis of the CBI versus the CBI kind. But it certainly carries the colours of the RBI versus the Government. In that, it’s a clear voice from some of the highest quarters that we may be hurtling into uncomfortable territory and that the government has probably crossed the line.

Red flags appear in recent speech

The red flags came in a speech last Friday (Oct.26) delivered as the A. D. Shroff Memorial Lecture in Mumbai by Dr. Viral Acharya, the deputy governor of the RBI, titled “On the Importance of Independent Regulatory Institutions – The Case of the Central Bank”.  In one line, it says don’t tamper beyond a point or we will have disaster. The speech begins with a reference to the 2010 crisis in Argentina, a real-life example that comes along “beautifully to make a communicator’s job easier”, using it to point out how the nation suffered when the Argentine government did not heed its central bank. In 2010, a New York judge had frozen the Argentine central bank’s account held at the Federal Reserve Bank of New York, following claims of investors that the central bank was no longer an autonomous agency but under the thumb of the country’s executive branch. India’s RBI, now it seems, is not so blatantly under the thumb of the central government.

In focus is the independence of the RBI, the central bank that, among its other roles, is the regulator for banks and is navigating through a critical time amid a host of burning issues, among them Non-Performing Assets (NPAs) of the order of Rs. 10 lakh crores that are crippling the banking system. This is not yet a crisis of the CBI versus the CBI kind. But it certainly carries the colours of the RBI versus the Government.

Some see the speech as an important step in speaking out at a time when the battle to preserve institutional independence has reached a turning point and the steam in the cooker can no longer endure the pressure. The only option, it would seem, is to blow the whistle and that is precisely what has happened. That’s not an unreasonable reading when the deputy governor follows up the Argentinian example to point out that “the risks of undermining the central bank’s independence are potentially catastrophic, a ‘self-goal’ of sorts, as it can trigger a crisis of confidence in capital markets that are tapped by governments (and others in the economy) to run their finances.”

Dr. Acharya made it a point to note that the theme of central bank independence for the lecture was suggested by Governor Dr. Urjit R Patel, and has inputs and ideas from other top leaders, present and former, at the RBI. In short, the words of one Deputy Governor are more than what he might think; they convey the sentiments of the larger body of leadership in the RBI. Consider that the deputy governor making the speech and indeed the Governor who suggested the topic are handpicked by the Narendra Modi government, and in fact the Governor has been under fire for, during and after the demonetisation move of 2016.  When they speak out against the establishment that chose them, it should be fair to assume that the problem is serious.

Within the RBI, there is a sense of disenchantment and even anger at a time when the nation and the financial system is going through a deep crisis. The speech caps a series of pointers that all is not well. On October 19, the RBI put out a dissent note on the draft report of the inter-ministerial committee for finalisation of amendments to the Payment & Settlement Systems Act, 2007. It argued, quite simply, that “there is no case of having a regulator for payment systems outside the RBI,” and that “the composition of the Payments Regulatory Board is not in conformity with the announcements made in the Finance Bill by the Finance Minister.”

The problem is a culture that looks at bad loans not as a signal that something is wrong, one that must land heavy on the borrower, who must face downgrades or suffer real penalties for falling short on the debt contract, even if it be for a day; rather it has become a bureaucratic process of classification of loans and of somehow allowing violators, defaulters and among them an assortment of rogues, looters and fixers (bankers not excluded) to get away with a system that is all too convenient.

Before that, on October 12, Dr. Acharya again took to a speech to explain why the RBI’s revised Prompt Corrective Acton (PCA) framework is an essential element of its financial stability framework and strikes at the root of NPAs that threaten financial stability. There have been a series of reports since then that the government wants to dilute the PCA, which essentially puts banks which cross thresholds on markers like capital, asset quality etc. in the sick bay, restricting their activities, including lending, to nurse them back to health. The government wants to relax these restrictions but the RBI is clear that this will be the wrong message to send out. A total of 12 banks are under the PCA now with different degree of restrictions.

Problem of bad loans is overweaning

At its root, the problem is a culture that looks at bad loans not as a signal that something is wrong, one that must land heavy on the borrower, who must face downgrades or suffer real penalties for falling short on the debt contract, even if it be for a day; rather it has become a bureaucratic process of classification of loans and of somehow allowing violators, defaulters and among them an assortment of rogues, looters and fixers (bankers not excluded) to get away with a system that is all too convenient.  In a mob, when everyone is looting, then the one who does not do so is also tempted to take a free ride since everyone is doing so and no one is punished.  

In the end, this is the money of the people being lost, all of it in conjunction with banks and a system that is tilted to favour the big borrower and penalise the little one. Ask any home loan borrower or a credit card user, and the story is how they were made to pay onerous fines even for a single day of default. But the message to the big borrowers is different, and the story here is how easy it is not to pay back. This must change and penalties must be severe. When businesses fail, as they every once in a while do, loans can go bad but banks must do their due diligence to ensure that a bad business cycle is not mixed up with bad governance systems. And when businesses go bad because of the people running them, action must follow. This must be the message given out in one voice – by the government and the RBI. If this is a cultural change that the RBI can deliver, it must be encouraged and supported to do so, not put under pressure by a government that is already suffering from loss of credibility on several counts. Let this not be more reason for the Modi government to come short.

(The writer is a journalist and a faculty member at SPJIMR. Views are personal)